issue: Trade

Gas vs. Gasoline

Posted on by The Progressive Policy Institute

America has a serious oil deficit. We consume almost three times as much oil as we produce. As a result, we send more than $250 billion a year offshore (mostly to our enemies and other bad guys) to import oil so we can keep our trains, planes, and automobiles running.

On the other hand, America now has a huge surplus of natural gas, enough to last us for 100 years or more. If we replaced the oil we import with domestic gas, we could end our energy dependence and stop enriching U.S. adversaries. But rather than convert from oil to gas, plans are afoot to export the gas!

The economics of importing oil and exporting gas make no sense. We currently pay about $100 to import a barrel of oil. We are exporting natural gas at a price that has the energy equivalence of about $25 a barrel. That’s right, we are buying energy as oil for $100, selling the same amount of energy as gas for $25.

Buying high and selling low – this is what passes for national energy policy today. Our leaders should be embarrassed.

In addition to the economics, the strategic implications of converting from oil to gas are huge.

About two-thirds of the oil we use is for transportation. Converting our transportation fleet to natural gas would almost eliminate the need to import oil. Our trade deficit would be cut in half, petro-despots would be deprived of their largest revenue source, and our economy would get a $250 billion shot in the arm – every year.

So why aren’t we doing it? Converting gasoline and diesel engines to gas is relatively easy and very safe. The challenge is the infrastructure – a national network of filling stations that need to be in place before people will convert their cars and trucks to gas. Building that infrastructure requires such a huge effort and coordination among so many actors that it is unlikely that the private sector can or will make the switch by itself. Among other things, investors will worry that OPEC will defensively collapse the price of oil as they did in the ’70s. Given these market realities, the only way this switch can possibly happen will be if the government steps up to catalyze and help underwrite the effort. 150 years ago the government made a similar commitment to enable the trans-continental railroad – which ushered in America’s great industrial expansion. Converting to natural gas could bring about a similar economic boom.

Installing the required new fueling infrastructure for gas-propelled vehicles would be a tremendous generator of new jobs. There are few other investments the nation could make with as large a payoff across so many areas of national concern.

For those interested in the math:

One barrel of oil = about 5.6 million BTU. One Mcf of natural gas = about 1.02 million BTU. (The actual energy content varies slightly depending on the grade of the oil or gas. These are industry averages.)

Energy equivalence: The BTUs in 1 bbl. oil = The BTUs in 5.6 Mcf natural gas.

1 bbl oil costs $96.75 and the same amount of energy in gas costs $25.59 (5.6Mcf x $4.57),

The energy cost ratio between oil and gas is roughly 4 ($100/$25).

That means we’re paying 4 times as much for an oil BTU as we get when we sell a gas BTU.

It also means that once we have completed the conversion, operating on gas instead of gasoline will reduce our transportation energy costs by almost 75 percent.

Photo Credit: Arimoore

Real Trade Deficits in Capital and Consumer Goods Near New (Negative) Record

Posted on by The Progressive Policy Institute

Many economists are racing to declare a ‘manufacturing revival.’ The latest to join the bandwagon is Paul Krugman. In his latest column, Krugman writes (my emphasis added)

Manufacturing is one of the bright spots of a generally disappointing recovery…..Crucially, the manufacturing trade deficit seems to be coming down. At this point, it’s only about half as large as a share of G.D.P. as it was at the peak of the housing bubble, and further improvements are in the pipeline…one piece of good news is that Americans are, once again, starting to actually make things.

Oh, how I wish Paul was right. Unfortunately, I still don’t see it in the trade numbers. In fact, the real trade deficits in capital and consumer goods are both nearing all-time (negative) records. Meanwhile, the real trade deficit for industrial supplies and materials has improved in large part because of an enormous surge in real exports of energy products, including coal, fuel oil, and other petroleum products (yes you read that right) and a sharp decline in imports of building materials. I don’t find either of these convincing proof of a resurgence of manufacturing.

As you might expect, time for some charts. Here’s a chart (below) of the real trade balance in capital goods in billions of 2005 dollars, calculated on a 12-month basis.

Capital goods include computers, telecom gear, machinery, aircraft, medical equipment–the heart of U.S. advanced manufacturing. Within a couple of months, if current trends continue, the capital goods trade deficit will be at a record level. What’s more, there’s no sign of any great domestic capital spending boom that could suck in imports.

And not to digress, these figures probably substantially underestimate the deterioration of the capital goods trade balance because of the import price bias effect , where the government statisticians do not correctly adjust for rapid changes in sourcing from high-cost countries such as the U.S. and Japan to low-cost countries such as China and Mexico (for a good reference see the new paper “Offshoring Bias in U.S. Manufacturing” by Susan Houseman, Christopher Kurz, Paul Lengermann, and Benjamin Mandel in the latest issue of the Journal of Economic Perspectives) .

Now let’s turn to consumer goods. Here’s the chart (right) of the real trade balance in consumer goods, in 2005 dollars.

No sign of any real improvement here either, I’m afraid. The trade balance retreated a bit during the recession, but since then has surged back. Once again, there’s no sign of a sustainable improvement in the trade balance.

The situation with motor vehicles is a bit more ambiguous. As the chart to the left shows, clearly there has been some gains in the motor vehicles and parts trade balance. However, it has started deteriorating again.

Finally, we come to the one area, industrial supplies and materials, where there has been a clear improvement in the real trade balance. Industrial supplies and materials includes fuel imports and exports; steel and other metals; building materials; chemicals; and a grab bag of other things including newsprint, audio tapes, and hair.

Since 2006, there has been roughly a $150 billion improvement in the industrial supplies and materials trade deficit, measured in 2005 dollars (I say roughly because this is one case where the chain-weighted procedures used to construct the figures gives quirky answers that aren’t additive. So when I give the following numbers, please please don’t divide them into $150 billion to get a share of the improvement). Part of that is a decline in real imports of crude oil, which fell by roughly $30 billion (measured from 2006 to the 12 months ending in March 2011). But another $30 billion, more or less, came from an increase in real exports of petroleum products such as fuel oil and lubricants. I’m not sure whether a gain in exports of fuel oil really tells us much about the fortunes of manufacturing overall.

Another contributor to the improved trade balance is a decline in the imports of building materials. Once again, not a sign of strength.

So I see no sign in the trade data of a great manufacturing revival. The topline improvement in the real trade deficit has mostly come from industrial materials and supplies, and within that from a swing in the energy sector imports and exports.

Let me finish with a quote from a piece that Paul Krugman wrote back in 1994. In that piece, he scoffed at worries that foreign competition was hurting U.S. manufacturing. He argued that

A growing body of evidence contradicts the popular view that international competition is central to U.S. economic problems. In fact, international factors have played a surprisingly small role in the country’s economic difficulties…. recent analyses indicate that growing international trade does not bear significant responsibility even for the declining real wages of less educated U.S. workers.

I wonder if he still believes that today.

Crossposted from Innovation and Growth.

The Fiscal Debate Is Missing Half the Picture – An Economic Perspective

Posted on by The Progressive Policy Institute

The following is an anonymous piece by an economist at an international financial institution. The views expressed here are solely those of the author.

Despite what politicians across the political spectrum will scream at you, the United States’ screwed up finances haven’t yet reached the level of an existential debt crisis.

To be clear, America must get its fiscal house in order, and ongoing debates and collaboration across the legislative and executive branches are important to righting America’s budgetary ship over the next few years. But let us dispel the notion that unduly draconian debt-reduction measures–that only touch the discretionary budget no less–must be enacted yesterday. Big picture reform of entitlement spending, increasing federal revenue, and scrutinizing the Pentagon’s budget must, and will, happen. However, the shrill, mostly right-wing political calls to cast ideologically-motivated yet relatively tiny budget cuts as the solution to a spending emergency will not solve the debt crisis and could create a culture that chokes off needed investment in critical areas. As any CEO will tell you, a certain level of borrowing to fund strategic investment is a critical component to reaping higher future returns. The same is true of public borrowing to support America’s long-term economic growth.

Here are three unique reasons why the U.S. continues to be in a position to borrow:

(1) Liquid financial markets and the reserve characteristics of the U.S. dollar create a nearly inexhaustible supply of creditors for our public debt. In plain English, this means that U.S. dollar assets are the safest global investment and savings vehicle and are easily accessible, keeping the federal government’s cost of borrowing relatively low (i.e., the US can harness global, not just national savings).

(2) Confidence in our monetary system to keep a lid on inflation will preserve U.S. Treasuries as desirable assets. Fear of inflation stoked by printing money to finance deficits is a primary fear of investors and not concern for the U.S. due to an independent Federal Reserve. The Fed appears to be aware and prepared for potential inflationary risks, and its track record, through several business cycles, has been praiseworthy as inflation, measured by the consumer price index, averaged 3.1 percent between 1982 and 2011.

(3) We are saving more domestically and could replace external demand for US dollar assets. A surprisingly large percentage of U.S. Treasuries remained in the hands of U.S. residents as of December 2010, and with the household savings rate doubling since its trough in 2005, the capacity to fund our public liabilities domestically will improve.

Long-term economic growth constraints erode debt sustainability in the US

The resulting ongoing and outlandishly panicked fiscal debate ignores a critical measurement of the nation’s economic health: our long-term economic growth potential. Not only is it a source of wealth and power, it is a major component of assessing our level of sustainable debt. Nominal economic growth – a function of increases to our stock of labor and capital — reflects a nation’s capacity to repay debt. When it is faster than the growth of new net borrowing then there is no problem. In other words, if your family’s income is growing faster than the amount you are borrowing, then your indebtedness is declining – a good thing! This is the dual assessment employed by international investors and rating agencies.

Borrowing to fund investment is critical to fostering future economic growth. By ignoring crucial investments in the nation’s stock of capital and labor, our politicians are mortgaging our future. Investment in public infrastructure, education, and immigration reform foster more rapid growth as they increase our stock of capital and labor, expanding economic capacity and productivity. By failing to be cognizant of the basic investment needs to maintain and expand our growth potential, our political leaders are just making political hay.

Hence, the fiscal debate on the Hill, which ignores economic growth potential, could ironically contribute to long-term market insecurity by raising our interest costs, and possibly lead to a greater debt crisis. What’s needed is a balanced approach, one that puts our long-term fiscal policy on a sustainable path through a combination of controlled spending, entitlement reform, revenue increases and with a contribution from the Pentagon, while committing to invest in our future.

Here are three critical areas of investment where the United States is failing to maximize growth potential by under-investing in capital stock and labor:

Public infrastructure: The United States’ capital stock is suffering from decades of neglect, increasing the cost of doing business and decreasing our competitiveness. The 2009 American Society of Civil Engineers infrastructure report card gave us a grade of “D”. Compared to some of our competitors — who are investing in high-speed rail, clean energy production, and smart grids – we may appear to be standing still. For example, Europe invests 5 percent of GDP in infrastructure while the United States spends less than 2.4 percent.

 

Educating our future workforce: Sadly, our secondary education system compares poorly internationally and, while our universities are the envy of the world, we manifest an artificial brain-drain as we expel U.S.-educated, non-citizens to the benefit of our international competitors. Our education system is one of the most expensive but yields only average results. According to the OECD, the United States spent 7.6 percent of GDP on all levels of education in 2007, almost 2 percentage points above the OECD average, but secondary and tertiary completion rates remained below the average of other advanced countries.

Immigration: Immigration reform can and should be viewed through this economic lens – we must create a reliable system of immigration to expand our future labor pool, increase economic growth, and produce the resources we need to help finance unfunded public liabilities.

Our political class will continue to yell at one another on CNN and Fox, but keep in mind that all spending is not the same, and that there are sound economic arguments to support crucial investment in these discreet areas for the long-term economic health of the country.

A Milestone in Trade

Posted on by The Progressive Policy Institute

In 1987 the G6 countries (Canada, France, Germany, Italy, Japan, and the UK) accounted for 55 percent of U.S. goods imports. That same year, China, Mexico and Brazil only accounted for 8 percent of imports.

In 2010 the U.S. reached a milestone–for the first time, imports from China/Mexico/Brazil exceeded imports from the G6 countries. In the year ending March 2011, imports from China/Mexico/Brazil equaled 32 percent of goods imports, compared to 31 percent for the G6 countries. Here’s another way of seeing the same thing. Please note that OPEC’s share, and the share of “all other countries,” don’t change very much. It’s really the G6 versus a handful of low-cost importers.

One final note. The shift in sourcing is most likely happening because the goods made in China/Mexico/Brazil are less expensive than the same goods made in France/Germany/UK. Unfortunately, the BLS import price statistics are not able to pick up the price drops from shifts in country sourcing.

Suppose for example that goods made in China are sold for one-third less than the same goods made in Japan. Then for the same physical quantity of imports, that shift in sourcing will cause the nominal value of imports to be one-third lower. This imparts a significant downward bias to the import penetration ratio.

Crossposted from Mandel on Innovation and Growth.

New Manufacturing Data Show Weaker Factory Recovery, Deeper Recession

Posted on by The Progressive Policy Institute

There’s been a lot of happy talk recently about the revival of U.S. manufacturing . According to an article in the New York Times, “manufacturing has been one of the surprising pillars of the recovery. “ In a Forbes.com column entitled “Manufacturing Stages A Comeback,” well-known geographer Joel Kotkin talks about “the revival of the country’s long distressed industrial sector.” The Economist writes that “against all the odds, American factories are coming back to life.”*

Truly, I’d like to believe in the revival of manufacturing as much as the next person. Manufacturing, in the broadest sense, is an essential part of the U.S. economy, and any good news would be welcome.

Unfortunately, the latest figures do not back up the cheerful rhetoric.

Newly-released data suggest that the manufacturing recession was deeper than previously thought, and the factory recovery has been weaker. On May 13 the Census Bureau issued revised numbers for factory shipments, incorporating the results of the 2009 Annual Survey of Manufacturers. The chart belows shows the comparison between the original data and the revised data (three-month moving averages):

The decline in shipments from the second quarter of 2008 to the second quarter of 2009 is now 25%, rather than 22%. And the current level of shipments in the first quarter of 2011 is now 9% below the second quarter of 2008, rather than only 5%. In other words, the new data shows that factory shipments, in dollars, are still well below their peak level.

The manufacturing recovery looks even more tepid when we adjust shipments for changes in price. Here are real shipments in manufacturing, deflated by the appropriate producer price indexes.**

Now that hardly looks like a recovery at all, does it? Real shipments plummeted 22% from the peak in the fourth quarter of 2007 to the second quarter of 2009. As of the first quarter of 2011, real shipments are still 15% below their peak. To put it another way, manufacturers have made back only about one-third of the decline from the financial crisis.

And while U.S. manufacturers have struggled, imports have coming roaring back. Here’s a comparison of real imports (data taken directly from this Census table) and real U.S. factory shipments (my construction, using Census and BLS data).

This chart shows that imports have recovered far faster and more completely than domestic manufacturing. Goods imports, adjusted for inflation, are only about 1% below their peak. That’s according to the official data. If we factored in the import price bias, we would see that real imports are likely above their peak (I’ll do that in a different post).

In other words, this so-called ’revival of U.S. manufacturing’ seems to involve losing even more ground to imports. That doesn’t strike me as much of a revival.

 

P.S. Oh, oh, what about all those manufacturing jobs that Obama’s economists are so proud of? This chart plots aggregate hours of manufacturing workers against aggregate hours in the private sector overall (the last point is the average for the three months ending April 2011).

What we see is that the decline in hours in manufacturing was deeper than the rest of the private sector, and the recovery has really not made up that much ground. Over the past year, aggregate hours in the private sector have risen 2.3%, while aggregate hours in manufacturing have risen 2.9%. That’s not much of a difference. In fact, probably the best we can say is that manufacturing has not held back the overall recovery.

*An important exception to the happy talk has been the recent report from the Information Technology and Innovation Foundation, entitled The Case for a National Manufacturing Strategy.

**For those of you interested in technical details, I used the producer price indexes for 2-digit manufacturing industries, as reported by the BLS. Could these estimates be improved on? Probably–but they are good enough to get the overall picture.

Crossposted from Mandel on Innovation and Growth.

Why Budget Line Items Don’t Die

Posted on by The Progressive Policy Institute

In today’s Washington Post, David A. Fahrentold marvels at what he calls the “Line Items That Won’t Die” – federal programs that benefit narrow interests, but somehow manage to keep getting funded: “One spends federal money to store cotton bales. Another offers scholars a chance to study Asian-American relations. Two others pay to market U.S. oranges in Asia and clean up abandoned coal mines.”

Fahrenthold attributes their success to having Congressional champions. The study of Asian-American relations, for example, takes place at a Honolulu nonprofit called the East-West Center, and enjoys the support of Sen. Daniel Inouye (D-Hawaii), who also happens to be chairman of the Senate Appropriations Committee.

But there’s also a broader story: the simple fact that when a government program benefits a narrow constituency, it’s very easy for that constituency to organize and make demands on legislators about why this program is worth keeping. The larger public, meanwhile is rarely aware, and even if it were aware, is unlikely to do anything.

Take the Market Access Program discussed in the article, which helps promote U.S. agricultural products abroad. A coalition of agricultural interests benefit greatly from this, and they are organized to advocate fiercely for its continuance and threaten to punish any Senator or Congressman who would vote against the program by withdrawing votes and campaign contributions. Nobody in the general public, however, is likely to care about or vote based solely on this single issue.

This is the difference in what congressional scholar R. Douglas Arnold has called “attentive publics” and “inattentive publics.” Attentive publics are the small groups that care deeply about particular policies, and as a result, are likely to be more influential because they care so intensely about that one issue. Inattentive publics are everyone else. The public might be outraged after reading about the Market Access Program, but the likelihood of most people following up are small. Think of it this way: If 1,000 people want money from you, but only one bothers to keep calling you up telling you why he’s so deserving and threatens to punch you in the face if you don’t give him the money, you’re probably going to give that one person money, especially if it’s likely the other 999 will not even notice or if they do, won’t remember.

Another way to think about it (borrowing from James Q. Wilson) is in terms of distributed costs and concentrated benefits. The benefits of a program that pays peanut and cotton farmers to store their bales and bushels in warehouses are solidly concentrated among peanut and cotton farmers. The costs are distributed to everybody else. But the cost per taxpayer is so small that it’s hard to imagine any group getting organized to fight this particular program. Whereas the farmers – well, they’re damn certain to do fight any cuts to the program. What results is what Wilson calls “client politics” – where small narrow interests work with the relevant congressional committee and executive agency staff to build a usually impenetrable consensus around the importance of a single program.

The challenge for governing is that the federal budget and tax code and regulatory apparatus are filled with thousands upon thousands of these programs, each protected by a small consensus, and without any public coverage. One only need to scroll through the Federal Register to see all the small issues that could potentially benefit small attentive publics at the expense of everyone else. Or better yet, look through the tax code to find all the little credits and deductions for very narrow benefits. It’s enough to make your head spin round and round and round. Jonathan Rauch has pessimistically called this condition “Government’s End.”

I don’t really have a solution. In part, this is the nature of our current system of government and the size and complexity of our economy. But the point is, these programs are very difficult to kill, and Fahrenthold’s story is just the tip of the iceberg.

Stop Dithering on Colombia Free Trade Agreement

Posted on by The Progressive Policy Institute

First on South Korea, now on Colombia, President Obama has been working assiduously to make trade agreements palatable to skeptics within his own party. By negotiating an “action plan” with Colombia on labor rights, he has removed any reasonable pretext for opposing a pact that has languished in Congress for five years.

It’s not clear, however, whether the anti-trade coalition of organized labor and Congressional liberals will take “yes” for an answer. Rep. Louise Slaughter (D-NY), ranking Democrat on the powerful House Rules Committee, vowed Wednesday to continue blocking the treaty. The pact, negotiated by the Bush administration, “turns a blind eye to rampant human rights violations and anti-labor practices of Colombia, where merely joining a union or advocating for workers rights can be a death sentence,” she said.

In fact, anti-union violence in Colombia has waned in recent years and there’s little evidence that the national government is implicated in it. Nonetheless, to allay Congressional criticism, Colombia pledges more vigorous action to protect union leaders as well as legal reforms to strengthen unions. Obama meets today at the White House with Colombian President Juan Manuel Santos to formalize the plan.

The free trade deal would lower Colombia’s high tariffs on U.S. agricultural and manufactured goods. The International Trade Commission estimates the U.S. exports to Colombia would increase by $1 billion if the treaty is approved (Colombia’s GDP in 2010 was $283 billion, and has been growing solidly for years). As Washington struggles to cut trillion-dollar deficits, that may not seem like much. But boosting U.S. exports – Obama has pledged to double them – is integral to bringing unemployment rates down.

While Washington has dithered, other countries have rushed into the breach. Colombia has been signing trade agreements with countries in Europe and Asia, and China is now its second-largest trading partner. It’s a vivid illustration of how U.S. policymakers’ inability to forge consensus on opening foreign markets is undermining our global competitiveness.

The political case for the free trade pact is even stronger. Colombia is one of America’s closest partners in South America. In a region rife with populist demagogues – the loudest being Venezuela’s virulently anti-American Hugo Chavez – Colombia stands out for its steady march in a liberal democratic direction.

And for its resilience. Nearly engulfed by drug cartels and narco-terrorism in the 1990s, Colombia, with America’s help, managed to defeat them while also strengthening the rule of law. The United States invested $8 billion over a decade in Plan Colombia, which now offers Mexico a model for its struggle against hyper-violent drug gangs that have overwhelmed civil authorities and killed over 30,000 people in recent years.

Congress’s refusal to approve the U.S.-Colombia free trade agreement is no way to treat a friend. It also puts the parochial interests of organized labor over the nation’s interest in opening markets to U.S. exports. The moderate House New Democrat Coalition has endorsed Obama’s efforts to smooth the way toward passage of the pact. It’s time for liberals to stop making excuses and let the deal get done.

The New Centrism

Posted on by The Progressive Policy Institute

I don’t do much politics, but I feel like I have to say something about the demise of the Democratic Leadership Council, which helped bring Bill Clinton to the Presidency in the early 1990s. A lot of writers have interpreted the end of the DLC as the end of centrism, and a sign that Washington has become completely polarized.

My take is different. To me, we’re moving into a new era of centrist ideas, based around the importance of innovation and investment, creative thinking about regulation and jobs, and a greater appreciation of a global economy built around cross-border collaboration rather than “you-me” economic nationalism.

Rather than the center disappearing, I think we’re going to start seeing both left and right start drawing on ‘new centrist’ ideas. Let me just give a few of them:

*The importance of innovation for driving economic and job growth. When businesses try and innovate, we should reward rather than punish them, especially given the innovation shortfall of the past decade.

*The need to  think about investment in broad terms, including human capital and knowledge capital. Our conventional economic statistics, which measure only physical investment, are giving us a misleading view of the economy.

*The need to understand the true nature of the long-term fiscal and entitlement problem: The long-term rise in medical spending is a total reflection of falling or flat productivity in the healthcare sector. If we can fix that–through a combination of techological advances and institutional change–we can in effect grow our way out of the entitlement problem.

*The importance of rising real wages for young educated workers as a sign of the health of the economy. Real wages for young college grads have been falling since 2000–we cannot operate a modern economy this way, because our young people can no longer afford to pay for the education they need.

*The need to find some way to lessen the burden of regulation without losing touch with our social values. We need a systematic process for examining the thousands of regulations and carefully adjusting or removing the ones that slow down growth, while protecting public health, safety, and the environment.

*The need to think about the global economy in terms of supply chains which cross national borders. The U.S. needs to make sure that we are part of global supply chains and that we are getting our fair share of the benefits.  And we need new measures of competitiveness that take account of the new world.

This piece is cross-posted at Mandel on Innovation and Growth

Why The Middle East Needs Economic Opportunity

Posted on by The Progressive Policy Institute

Uprisings across the Middle East have exposed the futility of America’s Faustian bargain with “moderate” Arab despots. Whatever happens in Egypt, it’s time for the United States to switch course and throw its weight unequivocally behind popular aspirations throughout the region for political freedom and economic opportunity.

No doubt this will be risky: If friendly autocrats go down, who knows what will take their place? Already there’s chortling in Tehran, because the fall of pro-western rulers could tilt the regional balance of power toward Iran and its satraps, weakening U.S. influence and further isolating Israel. For American strategists, however, such risks must be measured against the enormous costs of perpetuating a rotten status quo in the Middle East.

U.S.-backed regimes are far from the region’s worst, but they have contributed to the dismal conditions – stunted political and economic development, systematic abuse of human rights, endemic nepotism and corruption – that breed popular discontent and, at the extreme, the violent ideology of radical Islam. Washington’s support for authoritarian rulers has yielded neither lasting stability nor moderation, though it has compromised our own liberal values and engendered anti-American sentiment on the street.

Now, amid rising popular demands for change, America should aim not at stability, but at transformation in the Middle East. We should side with the young, civic activists and political reformers who want to throw off strongman rule; knock corrupt elites from their privileged perch; bypass central bureaucracies that stifle enterprise and dole out economic favors as a means of social control; empower civil society and women; and, in general, open Arab and Muslim societies to the modern, interconnected world.

Given our embrace of realpolitik in the Middle East, America doesn’t have a lot of credibility in the eyes of people now protesting in the streets of Cairo and other Arab capitals. But while our influence on political developments may be limited, there’s nothing to prevent the United States from addressing the economic frustrations that feed today’s revolts.

As PPI has documented in a series of policy reports (see here and here), the Middle East is the great outlier in today’s system of economic globalization. If you take out oil, the region’s share of world trade has remained strikingly small (about two percent of farm and manufacturing products), even as its population has nearly doubled over the past three decades. Exports are up in some countries, including Egypt and Pakistan, but the region as a whole attracts very little foreign investment. Poverty rates remain high – in Egypt, just under half the population is poor – and, according to the International Labor Organization, the Middle East has world’s highest unemployment rate: 10.3 percent compared to a global average of 6.2 percent.

This picture of economic stagnation is particularly grim for the young. Fully a quarter of them can’t find work. Little wonder that, as young men pour out of schools and universities into barren job markets each year, some are susceptible to Islamist extremists who offer them not only pay and adventure, but also a compellingly simple account of who is to blame for their misery – corrupt rulers in cahoots with the infidel West.

One practical way the United States can counter the radical narrative is to champion economic freedom and prosperity in the Middle East. The principle instrument here is trade and investment, rather than development aid. What these countries need is economic reforms that facilitate their integration into global markets, not wealth transfers from rich countries that end up lining the pockets of corrupt elites. To spur reform and growth, President Obama should ask Congress to pass a massive tariff-reduction bill based on the successful precedent of the Africa and Caribbean free trade agreement. A Greater Middle East Trade Initiative would provide the levers for lowering barriers to trade and investment in the region, promoting financial transparency, encouraging all countries to join the World Trade Organization, and removing obstacles to individual enterprise.

The nexus between trade and investment and economic reform is critical. As Peruvian economist Hernando De Soto has shown, massive state bureaucracies and bad laws smother entrepreneurship and drive a lot of economic activity underground. In Egypt, more people work in the underground economy than in either the private or public sectors. His studies also show that a low-income entrepreneur has to negotiate with scores of government agencies to start a business, and it years to get clear title to land.

Of course, Washington should press harder for political reforms and fair elections in the Middle East as well. But many in the region simply don’t trust Washington to embrace democracy if it produces outcomes we don’t like. By focusing on poverty, unemployment and jobs, the United States can work around such suspicions. Making life better for ordinary people is the best way to advance U.S. interests in the Middle East.

Import Recapture Strategy

Posted on by The Progressive Policy Institute

From the NYT, on rising Chinese export prices:

Markups of 20 to 50 percent on products like leather shoes and polo shirts have sent Western buyers scrambling for alternate suppliers…..Already, the slowdown in American orders has forced some container shipping lines to cancel up to a quarter of their trips to the United States this spring from Hong Kong and other Chinese ports.

It’s time for state and local economic development agencies to start honing their import recapture strategies. By ‘import recapture strategy’, I mean the judicious use of loans and other aid to help rebuild and restart manufacturing production and jobs that were lost to foreign factories.*

Yes, I know that sounds weird after all the manufacturing jobs that have been lost.  Anecdotally, the price differential between China and the U.S. was on the order of 35%.  Given the price jumps in the pipeline, all of a sudden the cost of U.S. production might be in spitting distance for some industries.That’s especially true since domestic manufacturers have the advantage of being close and flexible.

I’m talking here both high- and low-tech production here. The question is which industries are ripe for import recapture, and how many jobs could be created. Here I’m going to tell you an important  little secret–you cannot rely on the BLS import price data to tell you where the gap has closed between import and domestic prices. Two reasons:

* The BLS does not measure the difference between the price of imports and the price of the comparable domestic goods.   Just doesn’t.  Never has. It’s a gaping hole in the data.

*The BLS  does measure changes in import prices–but very very badly (see here and the conference proceedings here). To understand how badly, take a look at this chart, which supposedly tracks the price of Chinese imports.

If you believe this data, the price of Chinese imports into the U.S. has been effectively flat (plus or minus no more than 4%) for the past seven years, through the biggest import boom in U.S. history, the biggest financial crisis in75 years, and a 25% appreciation of the Chinese yuan against the dollar.  As the saying goes, “this does not make sense.”

This piece is cross-posted at Mandel on Innovation and Growth

Chinese-U.S. Exchange Rates and Knowledge Capital Flows: Why We Feel Poorer

Posted on by The Progressive Policy Institute

The short summary:   The Chinese policy of buying dollars can be best understood as an indirect purchase of U.S. knowledge capital–technology and business know-how.  That, in a nutshell, is why we feel poorer today. Unless the Obama Administration understands the link between the undervalued yuan and the global  flows of knowledge capital,  negotiations with China are doomed to fail.

Viewed in the usual economic light, Chinese exchange rate policy in recent years looks like a gift to the U.S..   By buying up dollars to keep the yuan low, China–still a poor country– is effectively lending money to the U.S.–still a rich country–to buy Chinese products.  According to the official statistics, the U.S. has run a cumulative $1.4 trillion trade deficit with China since 2005. But over the same period, Chinese ownership of  dollar-denominated financial assets in the U.S. has risen by $1.3 trillion.

To put it another way, the conventional statistics seem to be saying that  the U.S. is getting $350+ billion a year in cheap clothing, electronics products, and toys at no real cost today.  What’s not to like?

But if this explanation was really correct–if  that purchase of dollars  was a gift from China–the U.S. would  be feeling happy and prosperous right now.  We have received all of these cheap goods and services, without having to give up very many of our own resources.

But of course, the U.S. doesn’t feel rich and happy right now–we feel poorer, while the Chinese are feeling more prosperous. How can we explain this?

The  reason why the Chinese purchase of dollars seems like a gift is  because we have a 20th century statistical system trying to track a 21st century  global economy. We can do a decent job tracking the flows of goods and services and a passable job tracking financial flows.  But there is no statistical agency tracking global knowledge capital flows–and that’s where the real story is. Take a look at this diagram.

The first three boxes represent the conventional view: The U.S. gets cheap goods and services, and then pays for them by selling financial  assets.

But that leaves out the  the transfer of knowledge capital  from the U.S. to China. In effect, the Chinese purchase of dollars is a mammoth subsidy for the transfer of technology and business-know into China.

Consider this. When China keeps the yuan low, that’s an inducement for U.S.-based companies to set up factories and research facilities in China, both for sale in China and for imports back to the U.S. .  And that, in turn, requires a transfer of  technology and business know-how from the U.S. to China.

My favorite example is furniture makers.  Over the years, U.S. furniture makers had accumulated this vast storehouse of knowledge–for example, how to make  coatings on dining room tables that are less likely to chip or discolor from heat or liquids. That’s one of the differences between a low-quality and a high-quality table.

As the manufacturing of furniture was offshored to China, the knowledge capital had to be transferred as well.   And that, in turn, helped turn the Chinese furniture industry into a global exporting powerhouse.

Now, let’s stop and make  three points here. First, we need to compliment China. It is not easy to absorb knowledge capital from the outside and make good use of it.  Frankly, all sorts of other countries could have tried the same exchange rate trick, and it wouldn’t have worked for them.

Second, the transfer of knowledge capital to China doesn’t mean that the same knowledge capital  disappears in the U.S. However, our knowledge capital  does become less valuable because there is more global competition–and that’s why we feel poorer. (see my earlier post on the writedown of knowledge capital)

Third, what’s needed from Washington is a sophisticated  response that both focuses on rebuilding our own knowledge capital, while at the same time slowing down the exchange-rate knowledge capital pump. More to come on this.

crossposted at Mandel on Innovation and Growth

Labor Backs Trade (Yes you read that right)

Posted on by The Progressive Policy Institute

Last Friday the AFL-CIO and several big unions came out against the U.S.-Korea free trade deal.  As news, this was strictly “dog-bites-man” stuff.  The bigger story is the appearance of cracks in Labor’s usually monolithic opposition to trade pacts.

Several unions, namely the United Auto Workers and the United Food and Commercial Workers, endorsed the agreement after President Obama wrung concessions from Seoul on cars and U.S. beef earlier this month. Ford Motor Company, which strongly opposed the original deal negotiated by the George W. Bush administration on the grounds that it didn’t do enough to pry open South Korea’s auto market, is also on board.

The unusual split in Labor’s ranks makes it easier for Congressional Democrats to back Obama.   Although voting treaties up or down is the exclusive prerogative of the Senate, it’s significant that the deal also has the support of Rep. Sandy Levin (D-Mich), a tireless defender of the U.S. auto industry and long the House’s leading skeptic of free trade agreements.

If the Senate approves the treaty next year, it will be a major boost for Obama’s pledge to double exports over the next five years. It may also signal a shift in trade politics within the Democratic Party. As a candidate, Obama played to his party’s anti-trade gallery, even pledging to re-negotiate the 1994 North America Free Trade Agreement. Now, as President, he recognizes that opening overseas markets is integral to economic recovery. With consumers still winding down their debts, and businesses hoarding cash, a good part of the economic demand we need to create jobs must come from abroad.

In fact, the Commerce Department reported Friday that U.S. exports rose to their highest levels in more than two years. The U.S. trade deficit (in goods and services) fell to $38.71 billion, a more than 13 percent drop over the previous month and considerably less than the $44 billion economists had predicted.  Best of all, U.S. exports to China grew nearly 30 percent to reach a record high of just over $9 billion. Along with a slight decrease in Chinese imports, that narrowed the monthly U.S. trade deficit by 8 percent, to $25.52 billion. This was the best economic news we’ve had for some time, and it sent stocks soaring.

South Korea has the world’s 12th largest economy. By lowering its high tariffs and dealing with non-tariff barriers to U.S. communications and financial services firms, the deal could boost U.S. exports to South Korea by $10 trillion annually, the administration says. Crucially, thanks to Obama’s success in getting South Korea to modify its auto provisions, it exempts up to 25,000 U.S. vehicles from Seoul’s environmental and fuel economy standards, and builds in safeguards against a surge of imported cars from South Korea.

That was enough to satisfy the UAW and Ford though not, it seems, the rest of organized labor. Intriguingly, the automakers’ union also parted company from the AFL-CIO in backing another controversial Obama deal: his tax-cut compromise with Republicans. It’s another sign that, even within the progressive camp, arguments for spurring job-creating growth are prevailing over class warfare themes.

South Korea is more than a major trading partner. It’s also a key U.S. ally. North Korea’s recent artillery attack on one of its islands – and China’s refusal to condemn it – seems to have made Seoul more tractable about negotiating changes in the treaty.  In any event, the free trade pact also offers the United States an opportunity to cement relations with an prosperous market democracy that increasingly shares our apprehensions about Beijing’s propensity for throwing its weight around in the Asia Pacific.

The U.S.-South Korea free trade agreement would be worth ratifying on foreign policy grounds alone. But unlike several previous bilateral trade pacts with small nations, this one will deliver real benefits to America’s struggling economy.

Needed: A ‘Global-Compatible’ Tax System

Posted on by The Progressive Policy Institute

President Obama is thinking about a broad overhaul of the income tax system, closing loopholes and lowering rates. (“Obama Weighs Tax Overhaul in Bid to Address Debt”).

But in today’s global economy, any attempt to ‘fix’ the U.S. income tax system is fundamentally doomed. Financial and product markets are so deeply globally integrated that multinationals and wealthy individuals can easily  recognize their income in lower-tax countries, if they choose.

One simple statistic: In 2009 40% of U.S. imports and exports was ‘related-party trade’ –”trade by U.S. companies with their subsidiaries abroad as well as trade by U.S. subsidiaries of foreign companies with their parent companies.” That means companies are effectively trading with themselves, so they can choose which side of the transaction books the profits.

To put it another way, the global economy is the biggest loophole of all, and it can’t be closed without layer after layer of intrusive rules and regulations.  In a global economy, you can’t have a simple income tax system.

What we need is a ‘global-compatible’ tax system: That is, a tax system which acknowledges the existence of a global economy, so it doesn’t continually need to be patched to close loopholes.

The best global-compatible tax system that I know of is the value-added tax. The value-added tax, as the name suggests, taxes the value added in a country, not the income. Equally important, A VAT  taxes imports but not exports.  As a result,  it offers far less chances for gaming the system.

Now, countries can still compete on their level of VAT. Moreover, there are a lot of controversial issues that can seriously affect competitiveness. These include: How to make the VAT progressive; whether medical care and housing should be exempt; how to treat capital investment and R&D spending; and so on. Big important questions, but ultimately solvable.

If you want tax simplicity and fairness, global-compatible is key.

This piece is cross-posted at Mandel on Innovation and Growth

Obama’s Chance to Lead on Trade

Posted on by The Progressive Policy Institute

President Obama is in Seoul today for what promises to be a contentious meeting of the world’s leading economic powers. He probably won’t mollify China, Germany and other critics of the Federal Reserve’s plan to pump more money into the U.S. economy. But the President does have a chance to further his goal of doubling U.S. exports by bringing home an improved trade agreement with South Korea.

In addition to attending the G-20 summit, Obama is slated to meet with South Korean officials to finalize a bilateral free trade pact negotiated by President Bush. Congress has not ratified the treaty, which is snagged by concerns about U.S. auto exports to South Korea, as well as lawmakers’ eroding faith in the benefits of free trade.  The president said in June that he had instructed the U.S. Trade Representative to have all the outstanding issues “lined up properly” before he arrived for this week’s visit, so he could close the deal with Korea and present the agreement to Congress again in the coming months.

South Korea isn’t just a major trade partner, it’s also a key strategic ally and a counterweight to China’s growing heft in the Asia-Pacific. Since its tariffs traditionally have been much higher than ours, there’s little doubt that the agreement would spur U.S. exports and help offset weak economic demand at home. It requires South Korea to lower its high taxes on U.S. farm goods and open markets for insurance and other services to American firms.  As the treaty has languished in Congress, however, Seoul has been busy on other fronts, deepening economic ties with China and finalizing an important trade pact with the EU last month.

Although President Obama sounded an ambivalent note at best on trade during the 2008 presidential campaign, he understands that expanding U.S. exports is crucial both to creating jobs and shrinking America’s outsized trade deficits.  Now that he’s made the Korean deal a top priority, we’ll find out if the newly Tea Party-infused GOP will be more amenable to passing the treaty than Congressional Democrats were.

The agreement would lower tariffs on auto imports on both sides. South Korea’s are higher — 8 percent compared to 2.5 percent here. (The United States also would gradually lower a 25 percent tariff on imported pickup trucks.) Nonetheless, U.S. auto makers, especially Ford, have argued that the treaty would not bring down cultural and non-tariff barriers that have confined their sales to a sliver of South Korea’s lucrative auto market.

They have a point.  Seoul exports more than 400,000 vehicles (mostly Hyundais and Kias) to the United States each year, while manufacturing an additional 200,000 cars at U.S. plants. According the U.S. Commerce Department, U.S. auto makers sent a paltry 5,878 vehicles to South Korea in 2009. Ford’s Stephen Biegun notes that more than 70 percent of the cars made in South Korea are exported, while imports account for less than 10 percent of sales, well below the average of 40 percent in other economically advanced countries.

As an auto industry representative explained in testimony before Congress, Korea has an extensive web of non-tariff barriers that make it harder for foreign car makers to penetrate the Korean market.  Some of these are technical regulations like emissions standards and even license plate size. Establishing a clear link between such policies and the small U.S. market share in Korea isn’t always easy. But there’s no doubt that some of Korea’s policies reflect a well-entrenched hostility toward imports. For example, until recently anyone in Korea who bought a foreign car would automatically have their income taxes audited—a policy that chilled demand even after it was officially ended.

Ford, America’s healthiest car maker, sees itself as the chief victim of South Korea’s import-unfriendly policies. That’s because General Motors, through its Daewoo subsidy, makes cars in South Korea, selling more than 100,000 locally and exporting hundreds of thousands more elsewhere (including to the United States).

What can President Obama do to resolve the impasse over autos and get the U.S.-South Korea agreement through the Senate? He can’t reopen negotiations, but he can use the presidential jawbone to win binding side agreements with Seoul to remove non-tariff barriers to U.S. auto exports.  He could, in short, bring pressure on South Korea to fully liberalize its auto markets and embrace the reciprocal obligations that come with free trade.  Much like his powerful message in New Delhi that “India has emerged,” the president needs to make the case that South Korea has also fully emerged as a mature economy, and it can no longer justify the kind of protectionist and mercantilist trade policies that are more typical of poorer developing countries.

A more aggressive stance would show that the President is serious about doubling U.S. exports. But there’s a complicating factor: the global spread of auto production, design and supply chains. That makes it hard to say just how “American” any given car really is, or how many U.S. jobs are engaged in making cars.

Nonetheless, as long as the answer is “greater than zero,” the President has an obligation to ensure that major U.S. trade partners offer as much access to their domestic markets as we do to ours. And the Korean pact presents him with an opportunity both to restore U.S. global leadership on trade liberalization and to integrate America more deeply into the world’s fastest-growing markets in East Asia.

Photo credit: South Korea

Iran Buckles Under Sanctions Pressure

Posted on by The Progressive Policy Institute

The Obama administration won an important foreign policy victory yesterday as Iran skulked back to the negotiating table.  In other words, the latest rounds of sanctions imposed by the UN, United States, and European Union have worked.

To be clear, sanctions’ aim was never to “bring Iran to its knees,” as Supreme Leader Khamenei claimed in 2008.  Further, it’s easy to doubt their effectiveness when we we hear accounts that Tehran is skirting sanctions with fake bank accounts and false flags on ships’ registries. This narrative essentially implies that because Iran is evading sanctions, then they must not be working.

It’s exactly the opposite: Sanctions are imposed to make life difficult for Tehran, and stories about evasion are actually clear indications of their effectiveness.  Every second an Iranian official has had to spend time figuring out a way around a sanction is time he should be doing his regular job.

Sanctions have coincided with a significant economic reforms inside Iran, aimed at ending over $100b in government subsidies on everything from bread to energy.  Opaque attempts at economic reform appear to have been painful for average Iranians.  And while I am not enough of Iran expert to steadfastly link sanctions, a weakening domestic macro-economic situation, and Iran’s inclination to head back to the negotiating table, I’m happy to point out the not-so-odd coincidence.

Before we get too excited, it should be obvious that the outcome of new negotiations is far from certain.  Iran will likely play its tired game of engaging diplomatically while attempting to refuse meaningful compromise.  That’s why it’s crucial that the Obama administration, European Union, and UN not reward Iran just for talking.  To keep Iran from getting the bomb, the international community has to keep its boot on Tehran’s neck until the day it agrees to unfettered access to all of Iran’s nuclear facilities.

photo credit: Daniella Zalcman

Schwarzenegger Takes the Asian Express

Posted on by The Progressive Policy Institute

With his own state government deep in the red, Schwarzenegger needs cash to build a $40-billion high-speed railroad between San Diego, Los Angeles, San Francisco and Sacramento. Instead of resigning himself to critics’ attacks that now is not the moment to spend money on rail, the governor went abroad to strengthen California’s ties with overseas train builders and bankers. At a time when folks in Washington are scratching their heads over how to pay for high-speed rail, the Governor’s trip offers an instructive way forward.

On the first leg of his journey, Schwarzenegger cut a deal with the Japan Bank for International Cooperation to loan California funds for the rail project. (The exact amount was not revealed.) In return, the governor dangled the prospect that California would choose Japanese trainsets and a Japanese operator to run the railroad.

With this understanding in hand, the ex-actor marched to Beijing and struck what may be a better deal with the Chinese Rail Ministry. The agency announced that it could offer California a “complete package,” including financing, to build the high-speed railway. “What other nations don’t have, we have,” bragged a ministry spokesman. “What they have, we have better.”

Then it was off to Korea, where the governor rode on Korea’s fastest train, the KTX, with Hyundai executives and met with President Lee Myung-bak. Afterwards, he offered the assessment that Korea and California would “be a terrific partnership” and asked his hosts to be sure to bid on the California project.

Schwarzenegger is on to an old idea. In the 19th century, European governments, as well as private investors, helped finance America’s railroads. Competition was often ferocious between the different syndicates, which kept overall costs down while enriching the Wall Street middlemen who set up the investment tranches.

Schwarzenegger’s strategy of letting experienced rail operators propose financial deals to California in return for potential entry into its market comes in sharp contrast to the approach in Washington.

Ever since it proposed a high-speed rail program in April 2009, the Obama administration has kept foreign rail builders at arm’s length and peddled the notion that American manufacturers can upscale their expertise and produce their own state-of-the-art train systems.

So far, no domestic company has even remotely stepped up to this task. Pullman-Standard, the last U.S. manufacturer to build rail passenger cars, exited the business 25 years ago. General Electric makes world-class locomotives, but these are freight locomotives unsuited for speeds above 90 mph.

Schwarzenegger realizes that having invested tens of billions of dollars in their high-speed-rail industry, governments in Asia and Europe are ready to fight for a chunk of his state’s $40-billion project. Jobs and manufacturing opportunities in California will flow naturally from the demands of the new service – as long as it gets started.

Right now, nobody in Washington seems to know how to pay for high-speed rail. A paralysis is taking shape as the federal debt grows, with no long-range funding set up. Maybe the “governator’s” shrewd negotiations with Asian officials this week will bring some fresh ideas to policymakers.

Photo credit: Hyundai